In investment circles, ex-Fidelity mutual fund manager Peter Lynch is widely regarded to be among the very best. Not only did his 13-year management of Fidelity’s Magellan fund produce peerless results up until his retirement in 1990, but his subsequent influence on private investors has been vast. An early proponent of the celebrated investor tool, the price earnings growth factor – or the PEG, he also produced a now renowned book that encouraged investors to “buy what you know” and offered a way of chasing growth and dividends in the search for the next stock success.

Lynch published One Up on Wall Street in 1989 and offered an update in 2000 at the height of the dot com boom. What is surprising – given his self-confessed love of companies and the numbers behind them – is how little time he actually commits in the text to explaining his formula. Whilst understanding the nature of companies and their value is essential, the main thrust of One Up on Wall Street is that private investors can outperform institutions by applying what they see around them – what your wife is buying in the local shop could be more important than you think.

As a starting point, Lynch divides companies into one of six categories: slow growers, stalwarts, fast growers, cyclicals, asset plays and turnarounds. Among his favourites are the fast growers, which he describes as “the land of the 10- to 40-baggers”, although he insists that fast growth shouldn’t be confused with ‘hot’ companies and sectors. Meanwhile, the slow growers are large and aging companies – think utilities – where investors swap the upside potential of fast growth for the certainty of dividends. Stalwarts are slightly different, albeit he describes them as multi-billion dollar hulks that are not exactly agile but are nevertheless faster than the slow growers. He points to the stalwarts as ideal protection during recession and hard times.

Lynch and the PEGY

Lynch’s relationship with the PEG was cemented during his days at Fidelity when, he says, the ratio was used all the time when picking stocks. We recently assessed how another famous investor, Jim Slater, developed a version of the PEG that puts extra emphasis on future earnings forecasts. In essence, Slater divides the forward PE of a share by the estimated future growth rate in EPS to arrive at the…

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